04.12.2009

With the end of the tax year approaching and the income tax rate rising in April,  now is a good time to get your affairs in order and to plan your investment strategy for 2010.

Click on the links below for further information.

Tax Year End 2009/10 - Financial Health Check 
Financial Planning is a continuous process but this is a good time of year to review your affairs to ensure that you are making use of appropriate investment related tax breaks.
To assist with this review we hope that the following check list will be helpful. Whilst not comprehensive it does cover the main aspects of potential planning as follows:

• Pension Contributions
• Individual Saving Accounts (ISAs) 
• Use of Tax Allowances 
• Venture Capital Trust (VCT) 
• Enterprise Investments Schemes (EIS) 
• Inheritance Tax (Estate) Planning 
• Contact us for further advice 

To view as a pdf click here 

50% tax rate – your choices
From 6 April 2010, the top rate of income tax will increase from 40% to 50% for individuals with income above £150,000. The upper dividend rate increases from 32.5% to 42.5%, giving an effective tax rate of 36.11% on dividends received by a higher rate taxpayer. These changes are coupled with a phased withdrawal of personal allowances for those with income above £100,000, meaning that some will face an effective income tax rate of over 60%.

The government is determined the rate will bite, in particular limiting the ability of pension contributions to prevent income from being taxed at higher rates. Aggressive schemes will almost certainly face attack from HMRC. Nevertheless, high-earners wishing to avoid or at least delay the impact of the 50% rate still have some options available. Strategies could include:

• accelerating income into the 2009/10 tax year; 
• deferring the receipt of income; 
• consideration of the structure through which a business is operated; 
• attempting to convert income into capital gains potentially taxable at a lower rate; 
• consideration of tax efficient investments; 
• other strategies to bring income to just below the £150,000 threshold. 

There is a limited window for action and individuals should be planning now to minimise the impact of the new rate.

Employee Share Incentives 
Employee share incentives can be a valuable tool in motivating, rewarding and
retaining employees. They can also be tax-efficient, with gains liable to capital gains
tax (generally at 18% but possibly at 10%) compared with an income tax rate of 50%
(from 6 April 2010) and no national insurance contributions. However, there are a
number of alternatives and, in a complex area, it is easy to make expensive mistakes.

Read more by clicking here to view as a pdf.

 

• Pension Contributions

Except for high earners, individuals can now contribute up to 100% of their relevant earnings(with a high upper limit) to their pension fund, which may be in a number of “pots”. If you are a member of an occupational pension scheme then you can also have a personal pension within certain limits. With the fall in pension fund values now may be a good time to “rebuild” your pension fund using tax relief available of up to 40%. For example, if higher rate tax applies for a personal contribution of £10,000 HMRC will make a payment into your pension fund of £2,500 and in addition provide further tax relief in your own hands of £2,500. Contributions for the current tax year must be made by 5 April 2010.

• Individual Saving Accounts (ISAs)

Many millions of pounds are lost each year by tax payers who are in a position to use some or all of their ISA “tax free” savings allowance. This tax year the allowance is £7,200 for a ‘stocks and shares’ ISA (but from this tax year £10,200 for those who are age 50 plus). The maximum that can be invested in a ‘cash’ ISA is £3,600; if this is the case the balance remaining of £3,600 can be invested in a ‘stocks and shares’ ISA, to use the full allowance. If a smaller amount of, say, £2,000 is invested in a ‘cash’ ISA then the allowance balance of £5,200 can be invested in a ‘stocks and shares’ ISA. One can now also transfer money from a ‘cash’ ISA to a ‘stocks and shares’ ISA. It may be worth considering this to improve the interest/dividends available as the interest rates on cash deposits are now very low. Income(which can be paid out if required) and capital gains generated within an ISA are free from UK income tax and capital gains tax.

• Use of Tax Allowances

Capital Gains v Income – as the top rate of income tax is 40% (50% from 6th April 2010 on income above £150,000) as compared with a flat rate of capital gains tax of 18% it may be appropriate to consider investments which generate capital gains rather than income. Apart from the lower tax rate applicable on capital gains the first (£10,100 this tax year) of gain is tax free.  
                            
Married couples/partners should also consider the income tax advantage of changing the ownership of investment such that each spouse uses his/her personal income tax allowance (£6,475 until age 65) and also the basic rate(20%) tax band. Changing the ownership of investment income can produce significant tax savings but there are a number of other aspects to be considered when reviewing the situation.

• Venture Capital Trust (VCTs) 

The main tax advantages of this type of investment are that there is income tax relief available at 30% on investments up to £200,000 and the dividend income is tax free. However, one needs to bear in mind that 70% of the trust assets has to be invested in qualifying investments including shares in unlisted and AIM listed companies so these investments are higher risk in nature. For high earners they could be considered as an alternative to pensions, with the recent restrictions imposed.

• Enterprise Investments Schemes (EIS)

The main tax breaks here are income tax relief available at 20% and deferment of capital gains made up to one year before and up to three years after the date of the EIS investment. Also 100% of the investment can be carried back to the previous tax year. Importantly EIS investment should benefit from business property relief (BPR) after two years, which means that shares will not form part of an estate for inheritance tax purposes. Higher risk normally applies to these schemes.

• Inheritance Tax (Estate) Planning

Making gifts should reduce the value of an individuals estate for inheritance tax (IHT). Individuals can gift up to £3,000 per annum which is exempt for IHT purposes. Spouses each have their own exemption and for those who have not used their 2008/09 exemption this can still be used by 5 April 2010 before it is lost. There are other useful exempt gifts that can be made including normal expenditure out of income. The use of a trust may be appropriate. However, we are able to provide comprehensive investment and tax planning advice on inheritance tax and please let us know if a review in this fairly complex area of planning would be helpful.

Contact

At this time of financial uncertainty within the global economy it is perhaps even more important that all appropriate investment and tax planning opportunities are explored so that wealth can be maximised tax efficiently.

If you would like us to contact you regarding any of the matters discussed in this Alert please contact your usual Scott-Moncrieff adviser. Alternatively please don’t hesitate to contact us directly and we look forward to hearing from you.

Paul Bennett                                   Andrew Cumming 
0131 473 3500                               0141 567 4530
paul.bennett@scott-moncrieff.com   andrew.cumming@scott-moncrieff.com

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50% tax rate – your choices 

Accelerating income
One approach for owner-managers could be to bring income forward by taking bonuses or dividends before 5 April 2010. A dividend declared in 2009/10 will be taxed at the effective rate of 25%, compared to 36.11% in 2010/11. The company law formalities must be complied with to ensure the dividend is properly declared on the correct date. In some cases, it may be possible to arrange for funds to be lent back to the company in a tax efficient way.

Self-employed individuals (including partners) are assessed to tax on the business profits of the accounting period ended in the tax year. Bringing forward the date to which accounts are made up to pre-5 April would allow the maximum profits to be taxed at the 40% rate.

Of course, a number of factors will need to be considered. If the business is planning capital expenditure which will qualify for capital allowances, it may be worth considering whether this can be deferred until a later accounting period to obtain relief at the highest rate of tax. Similarly, disclaiming writing down allowances in an earlier period would preserve higher tax pool balances going forward so that relief is obtained at a higher rate of tax in later periods.

Deferring income
Shareholders of owner-managed businesses may be able to extract profits other than by dividend or salary. Income could be retained in the company and distributed when tax rates are lower, or could be taken by interest free loan. A loan would be a benefit in kind and result in tax on the benefit of the interest foregone calculated on HMRC official rates. There are tax consequences for a company making such loans which can result in it paying tax of 25% on the amount loaned (refunded when the loan is repaid or written off). It should also be noted that HMRC has indicated that it is aware of, and disapproves of, this type of planning. Legislation may be brought in to counteract these arrangements, and could well be retrospective in effect.

Another possibility is to use either an Employee Benefit Trust (EBT) or Employer Funded Unapproved Retirement Benefit Scheme (EFURB) to warehouse income until income tax rates fall. The company makes contributions to either the EBT or the EFURB, which can then be used to provide benefits to employees. Again, these structures may be viewed with disapproval by HMRC unless they are operated carefully.

Choice of business structure
Individuals carrying on a trade on their own account or through a partnership are liable to income tax on profits as they arise, as the partnership or sole trader has no separate legal personality from the person carrying on the business. Most LLPs are similarly 'transparent' for tax purposes. The 50% tax rate will apply to the individual sole trader or partner if their profits are above the £150,000 threshold.

Companies, on the other hand, are separate legal entities, and it is the company rather than the shareholders which suffers corporation tax on the company’s profits. The rates of corporation tax are much lower than income tax rates: 21% for 'small' companies (profits below £300,000) and 28% for 'large' companies.

It may therefore be worth considering whether an unincorporated business can be run more tax efficiently through a limited company. Incorporation of a sole trade or a trading partnership can generally be achieved without immediate tax charges, although there are disadvantages, such as the double charge to tax which arises when profits are extracted from the business through dividends or salary and potentially increased national insurance costs.

There may also be additional compliance costs to consider, as companies are required by law to produce accounts and make an annual return to Companies House. The owner-manager's ability to control dividend and salary flows, and hence income tax liabilities, therefore needs to be weighed-up against potential higher overall tax and running costs.

Turning income into capital
Approved share schemes allow employment income to be taken as a capital return. There are two main HMRC approved schemes: the Enterprise Management Incentives (EMI) and Company Share Option Plans (CSOP).

The EMI scheme is designed to target key employees of a small and growing company. An employee will be issued an option to purchase shares, and there will be no income tax or national insurance charge provided the exercise price of the option is not less than the market value of the shares at the time of grant. There should also be no income tax or national insurance on the ultimate exercise of the option. Any subsequent rise in value of the shares would be taxed as a capital gain.

There are limits on the types and size of companies that can use EMI options, as well as the number and value of options that can be issued. Also, the employee must work full time for the employer.

In contrast, a CSOP can be used for any size of company. There is an individual limit to the value of options of £30,000, but no company limit on the amount of options they can grant. No tax or national insurance contributions are payable when the option is granted or exercised, provided the option has been held for at least three years. Any rise in value of the share would then be subject to capital gains tax in the hands of the employee.

Another strategy for converting income into capital could be an owner-managed business looking for an exit route by way of sale which might consider reducing remuneration (taxable at income tax rates of up to 50%) to increase the potential sale proceeds (taxable at capital gains tax rates). Care needs to be taken to ensure that capital gains tax entrepreneurs' relief is not jeopardised.

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Tax efficient investments
The differential in tax rates between income and capital may make investments with a capital return more attractive, particularly if an income return would take a taxpayer over the 50% threshold. Investment advice should always be sought before planning is implemented.

Investment into Enterprise Investment Scheme (EIS) companies can provide income tax relief in the year of investment at 20% of the cost of shares, up to a maximum annual investment of £500,000. EIS companies also attract other capital reliefs which may be beneficial.

Venture Capital Trusts (VCT) attract income tax relief at 30% of the subscription up to a maximum of £200,000 invested in a year. Dividends from ordinary shares in VCTs are also exempt from income tax. There are also capital gains tax reliefs available.

Investment bonds are life insurance policies which invest in certain underlying assets. The bondholder does not pay capital gains tax on any gains, and may only pay income tax when the bond is finally encashed. However, the advantage of an investment bond is the ability to draw down 5% of the capital invested in the bond each year for 20 years without any immediate tax liability. It is possible to carry these 5% allowances forward, so if a taxpayer makes no withdrawals one year, up to 10% of the investment can be withdrawn tax-free the next year, thereby deferring the tax charge.

Other strategies
Gift aid payments reduce taxable income at the donor's marginal rate of tax, so where an individual's income is marginally in excess of the £150,000 threshold, a simple means of avoiding the 50% tax rate would be to make charitable donations. Relief for donations can be carried back to the previous year when the actual income for the previous year is known.

Pension contributions can also be used to reduce taxable income, although the limitation of tax relief to 20% for taxpayers with income over £150,000 has made pensions a less attractive option for many.

Married couples and civil partners should consider equalising ownership of assets to make the most of both spouse's personal allowances and lower rate bands. Interest bearing bank accounts should be held in the name of the lower earning spouse wherever possible, and other income producing assets such as rental properties could also be transferred either absolutely or at least put into joint names. Assets can generally pass between spouses free of tax, although there is anti-avoidance legislation which needs to be considered in some cases and gifts to non-UK domiciled spouses from a UK domiciliary are only exempt up to a value of £55,000.

Finally there is always the possibility of leaving the UK and moving to a country with a more attractive tax regime. Some countries, such as Switzerland, are actively marketing themselves to UK taxpayers unhappy with the prospect of paying half their income to HMRC. It can be difficult, however, to convince the tax authorities that the individual has genuinely left the UK, particularly where there are frequent return visits or close family or business ties with the UK. Anyone thinking of becoming non-UK resident will need to take further advice.

Summary
There are many steps that you can take to reduce your exposure to the new 50% rate of tax and you should be planning now to mitigate the effect as far as possible. However, HMRC has already indicated that it will take a tough stance in respect of any arrangements that they consider to be artificial, which makes good tax advice essential.

To find out more, or to discuss your specific options, please contact your usual Scott-Moncrieff tax adviser 

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